The countries of central and eastern Europe have shown moral clarity in the face of crisis. As millions of people flee the war in Ukraine, Poland and others have thrown open their borders to offer refuge. A sense of solidarity between former Soviet-bloc states seeking to create new paths for themselves in Europe has driven much of this response. These countries are bearing the cost of a broad European imperative to offer support to those who need it the most.
In return, the rest of Europe needs to come to the aid of these countries in a moment of economic turmoil. The proximity of central and eastern Europe to the conflict has spooked investors and prompted significant pressure on national currencies. Action is required now to help prevent this volatility from mutating into something altogether more serious.
Central and eastern European central banks have certainly not been complacent in their response. Foreign exchange interventions have been paired with interest rate rises to help support national currencies. While this combination has brought momentary calm, more can be done to stave off further volatility. Investors’ lingering doubts about how well these economies will cope with the strain of a protracted conflict could result in sustained pressure on their currencies as they bet on depreciation or take fright.
In the face of this pressure, central banks will have no choice but to take further action. This carries significant risk. If central banks are unsuccessful in their attempts to support currency values through higher interest rates, then inflation may continue to rise, threatening a “stagflationary moment” of low growth and high prices. Any broader slowdown in Europe provoked by high gas prices, especially in Germany — the dominant export partner of many central and European countries — would pose additional threats.
On top of this comes the risk of a private debt squeeze. The situation is particularly precarious for countries that have relatively high amounts of private debt denominated in foreign currencies. If exchange rates continue to fall, payments on this external debt will become more expensive.
The first task will be to expand the swap lines between the European Central Bank and non-euro central banks. Swap lines can provide a pipeline of euros into central and eastern Europe to service foreign-denominated debt, if needed. Their very existence should send a powerful signal to investors that there is no need to panic, with the ECB ready to intervene in a crisis. This alone should be enough to stave off further precipitous currency falls that could make swap lines necessary in the first place.
Investors contemplating an exit from central and eastern Europe should meanwhile think twice. The EU has already demonstrated a surprising willingness to take bold steps during this crisis and its commitment to its eastern European members should not be doubted. If nothing else, self-interest should motivate caution: those with positions in the region have more to gain from improving the resilience of these economies rather than abandoning them. Reactivating the Vienna Initiative, originally created in 2009 to help prevent capital flight by western-owned banks, is the kind of effort that can help.
European nations on the front line of the Ukrainian crisis undoubtedly find themselves in the midst of their own economic storm. Unusual political cohesion has been shown among the nations of Europe in recent times. Now is the moment to commit to economic solidarity too.
Source: Economy - ft.com
